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WHAT IS (NOT) MONEY?
MEDIUM OE EXCHANGE MEANS O F PAYMENT
by Bill Z. Yang*
Abstract
This note attempts to provide a formulaic defmition of money and discuss the distinction between
medium of excha nge and mean s of payment. The former refers to the set of assets in an economy
that people regularly exch ange for goods and services (a concept of
what ),
while the latter is a method
that facilitates delivery of money from one to another (a notion of ho w ). It suggests that money should
be exclusively defined as medium of exchange , rather than mean s of payment. With such a distinc-
tion established, one can uniformly explain why currency, demand deposits and smart cards are money
(because they are a medium of exchange), and why checks, money orders, or debit and credit cards are
not money (because they are only a means of payment but not a medium of exchange).
1.
Introduction
What is money? In economics, it is unanimously
defined as the
medium of exchange.
But its inter-
pretation varies from author to author. Some
authors refer to med ium of exchang e as anything
that is generally accepted as payment for goods and
services or in the settlement of de bts (Hubb ard,
2005 , p. 14),' white others use it as a synonym of
means of payment
(e.g., Thomas, 2006, p. 21).
These treatments, however, are not only pedagogi-
cally troublesome but also conceptually incorrect.
For example, almost all students get very confused
when told check is not money, in particular, right
after they had jus t learnt that m one y is anyth ing
that is generally accepted as paym ent. The stan-
dard argum ent in most textbooks is that check is
not money but the checking deposits are without
explaining why a check is not money. Mumbles
from s tuden ts wo uld often be A chec k is indeed
generally accepted as payment, by definition, why
isn 't it money? If a check is not money, then what is
i t?
To our knowledge, no textbook has directly
answered these questions. Therefore, it is necessary
to define money correctly so that one can easily
judg e whether a comm only-used means of pay-
men t is money, by deflnition.
This note is intended to provide such a formula-
ic definition of money. We define money as
medi-
um of exchange—the set of assets in an economy
that people regularly exchange for goods an
services from others. There are two key points
this definition. First, money must be an
asset
th
signifies a part of what its holder owns. Secon
people normally convert their assets from oth
forms to this specific one before exchanging fo
goods and services, implying that this set of asse
are generally accepted in transactions. By defin
tion, currency and demand deposits are money
while checks, credit and debit cards are not. This
because currency and checking deposits are the
owner's assets, whereas a check or a credit/deb
card is not a part of its owner's assets.
The n, wh at is check if it is not mo ney? W hy is
generally accepted in transac tions ? ChecJcs
well as debit cards, credit cards and money order
etc., are a means of payment, referred to as a ge
erally accepted (institutional) arrangement o
method that facilitates delivery of money from
one to another. For example, a (signed) che
essentially serves as a standardized permit th
authorizes the recipient to claim a certain am ount o
checkable deposits from the check writer's ban
account, but the check itself does not signify an
part of the writer's assets. That is, a check is
means of payment and hence generally accepted i
transactions, though it is not a medium of exchang
Conceptually, medium of exchange should NO
be used as a synonym of
means of payment;
th
medium of exchange stands for
what
(is paid
School of Econom ic Development, Georgia Southem University, Statesboro, GA 30460 -8152, E-mai
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and the means of payment concems "how" (to
deliver it). Once such a distinction is clarified, one
can uniformly explain why currency, checkable
deposits, and stored-value cards are money, and
why checks, debit/credit cards, or money orders are
not money. It is beca use the former are a medium of
exchange, whereas the latter are a means of pay-
ment but not a medium of exchange.
2.
Medium of exchange
payment
means of
Characterized by its primary function,^ money in
economics is defined as
medium of exchange.
This
defmition is perhaps universally adopted by all
economists . Interpretat ions for "medium of
exchange" differ, however. For example, many
authors refer to medium of exchange as "anything
that is generally accepted as payment,"' and others
treat medium of exchange as a synonym of means
of payment. These treatments have caused lots of
confusion in the classroom: following the definition
students would conclude that a check is money,
because a check is a means of paym ent and "gener-
ally accepted as payment." But they were immedi-
ately told that a check is not money Confused? Of
cou rse Such confusion stems from the above inter-
pretations for medium of exchange; they are con-
ceptually incorrect
We now provide a correct and formulaic defini-
tion of money; following it one can directly judge
whether or not a means of payment is money,
hy
definition.
We also articulate why "medium of
exchange" and "means of payment" are two differ-
ent concepts, and hence why money should be
exclusively defined as a medium of exchange but
not a means of payment.
As illustrated in Figure 1, the term "medium of
exchange" is sufficiently self-explanatory; when
one plans to trade something for something else
from another, she first converts it to a medium of
exchange, and then trades the medium of exchan
for what she wants to buy. A medium of exchan
has two key features: First, it represents a part of
owner's assets; second, it is commonly accepted
transactions. We refer to medium of exchange
the set of assets in an economy that people reg
larly exchange for goods and services.^
In a modern payment system, an exchan
process essen tially takes two steps. At step 1, pote
tial buyers allocate a part of their assets in the fo
of, or directly exchange their goods or services f
a specific type of assets that is ready to make pa
ment. For example, when one works and gets pa
she actually trades her labor service for ba
deposits or currency. At step 2, buyers exchan
their bank deposits or currency for goods and s
vices from sellers. Clearly, checkable deposits a
currency are a part of people's assets and serve a
medium of exchange in transactions. By definitio
checkable deposits and currency are money.
A related question is: How do buyers deliv
money to sellers? In other words, how to make pa
ment? In the real world, people have gradua
developed a variety of means of payment—gen
ally accepted inst itut ional arrangements
methods that facilitate delivery of money fro
one to another. For example, a buyer may wi
draw currency from her bank account or ATM a
then hand-to-hand deliver it to make payment.
this case, currency also serves as the ultimate me a
of payment; when cash changes hands, payment
made and exchange is completed.
To deliver cash hand to hand is not the on
means of payment, however. Writing checks
another very popular method to make payme
Unlike cash, a signed check itself does not car
any value of the check writer. In fact, it only pla
a role of a
standardized permit
that authorizes
recipient to claim a certain amount of checkab
deposits from the check writer 's bank account. As
signed check changes hands, payment is not rea
completed until the recipient has finally receiv
Assets
(Medium of exchange)
Money
Buyer
Seller
Goods or services
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the funds, as illustrated in Figure 2. That is, writing
a check is an institutional arrangement that facili-
tates transfer of demand deposits from one's
account to another's, but the check itself is not a
medium of exchange. By definition, check is a
means of payment but not money.
In general, money serves as the ultimate means
of payment (Shiller,
2003 ,
p. 206), but not every
means of payment must be money. This is because,
by definition, a mediu m of exchange conveys a part
of one's assets ready to be traded for good s and ser-
vices from other people, whereas a means of pay-
ment (e.g., checks) may not carry any value and
only help deliver money. In other words, med ium of
exchan ge is a concept of
what
is to be paid , wh ile
means of payment is a notion of how to deliver it.
Hence, medium of exchange and means of
payment are NOT synonymou s. Therefore, we
should not refer to money as a means of payment,
or anything that is generally accepted as payment.
Rather, money should be
exclusively
defined as
medium of exchange—the set of assets in an
economy that people regularly exchange for
goods and services.
Pedagogically, a good definition (of money)
should be formulaic; following it one can conclude
correctly what is money and what is not money. By
definition, a means of payment is generally accept-
ed in transactions, because it is institutionally
backed by the current payment system. To deter-
mine whether a specific means of payment is
money, a simple criterion is to see whether it car-
ries value, physically or digitally. With such a cri-
terion, for example, one can elucidate why e-cash
and store-valued cards are also money, becau se they
convey their holders' assets digitally. Likewise, one
can explain for why debit cards, e-checks, money
orders, bank checks, traveler's checks, credit cards,
etc. are not money, because they do not carry any
part of payers' assets and only help deliver money
under a commonly accepted institutional arrange-
ment.'*
3.
Functions of some often-used
means of payment
In the previous section, we compared a check t
a standardized permit. W hat about other non
money means of payment? Since debit cards and e
checks are just electronic version of chec ks, the
can be interpreted as e-permit. Similarly, mone
order, cashier's check and traveler's check essen
tially serve as standardized receipts. Their issue
plays a role of gene ral cashier, wo rking for a
recipients. For example, when one buys a mone
order from post office with cash, the money is pai
to this cas hier (the post office), wh ile the m one
order is the receipt with which the recipient wi
claim the payment from the issuer later.
Table 1 lists some often-used means of pay men
and their functions.
Conclusion
This note is intended to provide a correct an
formulaic definition of money; with it that one ca
easily determine what is money and what is n
money. We emphasize two points: First, medium o
exchange and means of payment are not synony
mous; medium of exchange is the set of assets in a
economy that people regularly exchange for good
or services, while a means of payment is a genera
ly accepted institutional arrangement or metho
that facilitates delivery of money from one to anoth
er. Second, m oney should be exclusively defined a
medium of exchange but not means of payment o
anything that is generally accepted as payment
With such a distincdon established, one can explai
consistently w hether or not a specific means of pa y
men t is money and why. It may help to bett
understand the concept of money in economics an
avoid unnecessary confusions caused by the con
ventional but incorrect definitions of money.
M o n e y
Checking deposi ts
Assets
Buyer O j e ^ (_£.P££niii) ^
<
Seller
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TABLE 1
Functions of some often-used means of payment
Means of payment
Functions
Does it carry one's assets?
Is it money
Currency
Checking deposits
E-cash
Stored-value cards
Checks
E-checks
Debit cards
Credit cards
Money orders
Cashier checks
Traveler 's checks
Medium of exchange
Medium of exchange
E-briefcase
E-wallet
Permit
E-Permit
ID/Permit
ID/IOU
Receipts
Receipts
Receipts
Yes
Yes
Yes
Yes
N o
N o
N o
N o
N o
N o
N o
Yes
Yes
Yes
Yes
N o
N o
N o
N o
No
N o
N o
Footnotes
1.
Similar interpretations for medium of exchan ge
can also be found in, for example, Mishkin
(2004,
p. 45), Thomas (2006, p. 19), and Bade
and Parkin (2002, p. 253), among others.
2.
Mo ney has three (or four) functions: Me dium
of exchange (the primary one). Unit of account
and Store of value (some authors add the fourth
—Standard of deferred payment). We use an
acronym MUSt to help our students remember
these functions with ease.
3. For exam ple, see Hub bard (200 4, p. 14),
Mishkin (2004, p. 44), Thomas (2006, p. 19),
and Burton and Lombra (2005, p. 24), among
others.
4 .
For exam ple, see Burton and Lom bra (2006 , p.
24), Miller and VanHoose (20 04, p.6), and Bau -
mol and Blinder (1999, p. 626), among others.
5.
Ou r definition for mo ney is very close to
Mankiw 's (2003, p. 220 ): Mo ney is the set of
assets in the economy that people regularly use
to buy goods and services from other people.
Frank and Bemanke (2004, p. 596) also share a
very sim ilar definition. We replace use [it] to
buy by exchan ge [it] for to emp hasize the
difference between a medium of exchange and
means of payment. For example, when people
use checks to buy goods and services from
other people, they do not exchange checks for
goods and services; rather, they mean to
exchange their checking deposits for goods and
services.
6. A practical way to jud ge whether a mean s
payment carries value is whether you can ha
your m on ey back with an institution
arrangement through the payment system,
you happen to lose it.
References
Baumol, William J., and Alan S. Blinder, 199
Economics: Principles and Policy 8th Editio
Dry den.
Bade, Robin, and Michael Parkin, 2002.
Found
tions of Macroeconomics Addison Wesley.
Burton, and Lombra, 2006. The Financial Syste
and the Economy: Principles of Money a
Banking
4th Edition, Thomson South-Western
Frank, Robert H. and Ben S. Bemanke, 2004.
Pri
ciples of Economics
2nd Edition, Irwin McGra
Hill.
Hubbard, Glenn, 2004. M oney the Financial Sy
tem
and the Economy
5th Edition, Pears
Addison Wesley.
Mankiw, N. Gregory, 2004.
Brief Principles
Macroeconomics
3rd Edition, Thomson Sout
Westem.
Mishkin, Frederic S., 2004. The Economics
Money Banking and Financial Markets
7
Edition, Pearson Addison Wesley.
Shiller, Robert,
2003.
The New Financial Orde
Princeton: Princeton University Press.
Thomas, Lloyd B., 2006.
Money Banking an
Financial Markets
Thomson South-Wester.
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